hello everyone hi welcome to the channel

of Wallstreetmojo friends today we are going to learn tutorial on CAPM that

is the capital asset pricing model the beta that’s we are going to learn will

be learning definition formulas and how it is calculated on the excel so when we

invest in stock market how do we get to know that stock A is less risky than

stock B what is the case what is the reason difference can arise due to the

market capitalization revenue size growth management etc so can we find a

single measure which tell us which stock is more risky the answer is yes and we

call that as CAPM that is a capital asset pricing model asset pricing model

beta or capital asset pricing beta pricing model beta you can say in this

tutorial we are going to really look at couple of things we’ll start with the

definitions let’s begin the first definition of CAPM beta CAPM beta so it

is basically a measure of volatility or systematic risk of a security or a

portfolio in comparison to the market as a whole beta is very important measure that is used as a key input of the DCF valuation

if you wish to learn DCF you can go on and learn in the investment banking

course there in which is available in wallstreetmojo see now CAPM beta

formula that’s the second thing that we are going to learn that is the formula

if you have a slightest of the hint regarding the DCF modelling then you

would have heard about the capital asset pricing model that calculates the cost

of equity now if you calculate the cost of equity as for the books then you know

this cost of equity is equal to you can say the risk-free rate that is the RF

plus you have to multiply beta into the risk premium so this is going to be a

cost of equity now the risk-free rate over here you can

say I’ll show you know in a diagram as you can see the risk-free rate plus beta

into this premium this is basically the government’s rate that is at regenerated

the rate on investor expects from the completely risk-free investment and

should be current cash flow beta is your sensitivity it is a function of both the

business risk as well as the financial risk consider everything beta is a

measure of systemic risk which will study risk premium is basically the

extra gain that your you’re getting because of taking the risk apart from

the risk-free rate as your risk premium so investing in stock market is it

riskier than the investing in government bond investor expects a higher return to

reduce induce them to take the higher risk of investing in equities so if you

have not heard about beta yet then you need not worry

this tutorial will explain you about the beta in the most basic way let us take

an example when we invest in stocks it is but human to pick stocks that have

highest possible returns however if one chases only returns then the other is

corresponding elements is missed that is we are talking about over here is risk

so actually every stock is expected to have two types of risk one is non

systematic risk then another a systematic risk we’ll discuss both of

them non systematic risk includes the risk that a specific two company or

industry this kind of risk can be eliminated through diversification and

you can say this car across the sectors and companies the effect of the

diversification is that the diversifiable risk of the various equities

can offset each other systemic risk are the those risk that affects the overall

stock market systemic risk can be cannot be mitigated through diversification but

can be well understood why are an important risk measure that is called as

beta approaches none so now what is beta beta definition beta is a measure of the

stock risk in relation to the overall market as you can see over here in the

diagram return on the stock over the risk for a return Beta 2.0 this is

1 below that is 0.5 and this is the risk of the market or the risk-free rate

so this is higher beta is higher risk a lower beta is lower risk this is in the

indifference point beta 1 over here of the stock is the 1 that is has the

same level of the risk and the stock market hence if the stock market Nasdaq

on NYC rises up by 1% then the stock price we will also move by 1% the stock price will and if the stock market moves down by 1% the stock price will the stock price will also move down by 1% so if

market in store price stock price will also vary in this case if the beta is

greater than 1 that is 2 over here if the beta of the stock is greater than 1

then it implies that the higher level of risk and volatility as compared to the

stock market though the direction of the stock price changes will be same

however the stock price movements would be greater than the extremes like for

example assume that the beta of let’s say there is an ABC stock is two over here

then if the stock market moves up by let’s say 1% let’s say it goes

up by 1% then the stock price of ABC will move by 2% higher that

is 2 is a beta so the stock price of ABC will move by the 2% higher

returns in the risk market however if the stock price moves down by 1%

the stock price of ABC will move down by 2% thereby signifying higher

downside risk as well if the beta is greater zero and less than one that is beta is 0.5 if the beta of the stock is

less than 1 and greater than 0 it implies that the stock price will move

with the overall market however the stock price will remain less risky and

volatile like for example if the beta of the stock of XYZ is 0.5 it means that

the overall market moves up or down by 1% exit price will show an

increase or decrease in by 0.5%